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The State of Proxy Access Reforms

With the rise of shareholder activism led by what some refer to as “constructivists”, “reluctavists” or “suggestivists” (and, yet others, those who commit “extortion”), shareholders have become increasingly distrustful of leaving matters of corporate governance to management and boards. One tool that investors can rely on is exercising rights pursuant to a proxy access by-law, or, in Canada, the statutory rights of certain shareholders.

Proxy access is about enabling shareholders to influence who governs a company, and by extension, how the company proceeds with its affairs. It expands the activist shareholder’s quiver of offensive tactics by giving shareholders the right to nominate candidates to the board of directors and, in the United States, have information about those candidates included in the management’s proxy statement at the expense of the company. In Canada, the current rules do not provide the right to include shareholder nominees on the same form of proxy used by the company, so shareholders resort to preparing costly dissident proxy circulars that provide an overview of the nominees, as well as the overall thesis behind the shareholder’s actions.

In essence, proxy access preempts the need for an expensive, drawn-out, and often all-consuming proxy battle. All shareholders are given control of the board nomination process through their vote at the annual meeting, and can directly select the most qualified or best-positioned candidate to replace unproductive or misaligned directors.

USA

In August 2010, the Securities and Exchange Commission (SEC) adopted changes under Exchange Act Rule 14a-11 to the federal proxy rules in order to “facilitate the rights of shareholders to nominate directors … as a matter of fairness and accountability”. The changes, which are now colloquially referred to as the ‘3/3/25 Rule’, gave shareholders who: (i) owned at least 3% (whether held individually or as an aggregate of a group) of the total voting power of the company’s securities that are entitled to be voted on the election of directors at the annual meeting, (ii) for at least 3 years, (iii) could nominate up to 25% of the company’s directors. In July 2011, the United States Court of Appeals for the District of Columbia Circuit vacated the rule, stating that the SEC “acted arbitrarily and capriciously” and” inconsistently and opportunistically framed the costs and benefits of the rule”. The SEC, in response, permitted companies to adopt proxy access bylaws of their own accord.

In November 2014, the New York City Comptroller submitted 75 proxy access proposals through the 2015 Boardroom Accountability Project at companies targeted because of corporate governance deficiencies with respect to environmental liabilities, executive compensation and board diversity. To date, well over 100 U.S. companies have adopted proxy access bylaws (up from 6 in November 2014, and including household names such as Apple Inc., Coca-Cola Co., General Electric and McDonald’s Corp.), with the issue gaining momentum as we head into the 2016 proxy season, for which the Comptroller has already submitted more than 70 proxy access proposals. Overall, roughly 10% of S&P 500 companies have adopted proxy access by-laws.

Canada

Proxy access bylaws have not, as of yet, been an important consideration for most Canadian companies, largely due to the fact that under existing corporate laws, shareholders owning 5% (or shareholders representing 5% of shares in the aggregate) can nominate directors under a statutory mechanism (in Ontario, Business Corporations Act, RSO 1990, c B.16 s 99; federally, Canada Business Corporations Act, RSC 1985, c C-44, s 137). In Canada, director nominees are most often selected by an independent committee of the board of directors, which is responsible for identifying and nominating candidates. Extending the proxy access right in Canada is important due to the fact that most shareholders vote on the directors nominated by that committee prior to the meeting with a proxy form, making nominations at the annual meeting useless. In addition, in order to rely on the statutory mechanism, the nominating shareholder must limit the content of the nomination in the directors’ circular to 500 words, which must be submitted many months prior to the meeting date; activist shareholders do not frequently rely on the company’s proxy circular, for fear of too heavily relying on it as the only voice promoting the shareholder’s nominees. Over and above that, separate rules contained in advance notice bylaws adopted by a company are now widespread, requiring shareholders to submit detailed and compliant nomination proposals well in advance of the meeting.

Approaches

There are generally two approaches that can be taken by companies trying to determine how to proceed. A company can take a “wait and see” approach and not act until a shareholder makes a proposal for the adoption of proxy access bylaws. Under this scenario, the proposing shareholder will be able to control the dialogue and suggest terms that may not be as preferable to the interests of the company if the company had led with its own version of the bylaw. Although most companies have adopted the ‘3/3’ elements of the 3/3/25 Rule, many have reduced the percentage of directors that can be nominated and placed limits on the number of shareholders acting together in order to form a 3% aggregate.

Under the second approach, the company can propose its own form of the bylaw, preemptively adjusting it to reflect its own appetite for shareholder participation in the nomination process.

The two major proxy advisory organizations have, so far, indicated different approaches on how they will evaluate proxy access bylaw amendments. Institutional Shareholder Services (ISS) has stated that it will generally recommend a vote in favour of proxy access proposals that abide by the 3% for 3 years standard, with a 25% limit on the number of directors nominated by the shareholder. On the other hand, Glass, Lewis & Co. has stated that it will review proposals on a case-by-case basis, and will not make broad recommendations.

In the United States, the Council of Institutional Investors, a nonprofit association of pension and benefit funds representing over $3 trillion USD assets under management, has been vocal about its position on proxy access, which it considers a “crucial mechanism”. Similarly, the Canadian Coalition for Good Governance (CCGG), a coalition of investors who together manage $3 trillion CAD in assets on behalf of funds and institutional investors, has come out with full-force support of proxy access reforms, suggesting even broader rights to shareholders. The most notable reform suggested by CCGG would be to eliminate the holding period, so that any shareholder meeting the requisite percentage would be able to nominate directors; this, as CCGG suggests, would eliminate the “two classes of shareholders” created by a holding condition.

Finally, as pointed out by another commentator, the issue of proxy access may well be one that is merely symbolic, with little material effect on activist endeavours. The type of shareholder that typically attempts to reconstruct a board of directors—most often, an activist hedge fund—does not often maintain long-term positions in a company. And as a comparison of13D filings (in the United States) and early warning reports (in Canada) to the occurrence of activist campaigns reveals, this type of rich and nimble investor becomes active in a stock for the very purpose of surfacing shareholder value through corporate reforms. This essentially means that proxy access and proposal rights may, ultimately, have little to no impact, and may divert investment dollars into companies that have not yet adopted these reforms. It remains to be seen whether proxy access will remain in the spotlight in the 2016 proxy season.

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Norton Rose Fulbright's Special Situations Team has played a leading role in Canada’s most high-profile shareholder activist and defence mandates, as well as complex reorganization transactions. The Special Situations Law blog is about sharing our insights with you. With videos discussing shareholder activism, links to relevant case law and legislation and incisive commentary about regulatory and legal developments, our blog includes a wealth of resources and perspectives on special situations law.